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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Day: January 24, 2013

If you grow book value, particularly if your liabilities are short, you will grow market value. Many reinsurance and insurance companies aim at growing fully convertible book value per share.

Fully convertible book value per share assumes that you invest your dividends in the common stock (without taxation), and thus compound your gains through reinvestment, taking account of dilution. Hmmm… when will someone dream up the idea of structuring an insurance company as an MLP or a REIT? I don’t think it is likely, but maybe someone could dream it up.

It also implies that all possible dilution is factored in from convertible preferred stock or convertible bonds. Now insurance companies tend to trade near book value over the long run, so companies that can grow their book value rapidly and pay dividends can be interesting investments. Particularly where the liabilities of the company are short — property reinsurance or personal lines insurance, growth in book value plus dividends tends to be a reliable indicator of value creation.

If liabilities are longer, it gets more questionable, because under-reserving becomes more likely — it is very hard to be certain of the reserving of long-dated or volatile coverages.

Anyway, here is a list of insurance companies, and how they have accumulated book value plus dividends over the past seven years. Note that this is a mathematical calculation off a limited database, and that splits and M&A can throw this calculation off. With that caveat, here is the list:

company

ticker

sic

img_desc

mktcap

Growth of FCBV

Life Partners Holdings, Inc.

LPHI

6411

0712 – Insurance (Miscellaneous)

50.7

76%

Universal Insurance Holdings,

UVE

6331

0715 – Insurance (Property & Casualty)

185.2

75%

CNinsure Inc. (ADR)

CISG

6411

0712 – Insurance (Miscellaneous)

337.6

56%

Amtrust Financial Services, In

AFSI

6331

0715 – Insurance (Property & Casualty)

2,128.7

38%

Employers Holdings, Inc.

EIG

6331

0715 – Insurance (Property & Casualty)

652.6

32%

Enstar Group Ltd.

ESGR

6331

0715 – Insurance (Property & Casualty)

1,951.0

26%

Tower Group Inc

TWGP

6331

0715 – Insurance (Property & Casualty)

734.8

25%

Amerisafe, Inc.

AMSF

6331

0715 – Insurance (Property & Casualty)

508.5

23%

Humana Inc.

HUM

6324

0706 – Insurance (Accident & Health)

11,297.2

21%

Allied World Assurance Co Hold

AWH

6331

0715 – Insurance (Property & Casualty)

2,856.1

21%

Arthur J. Gallagher & Co.

AJG

6411

0712 – Insurance (Miscellaneous)

4,441.2

20%

Willis Group Holdings PLC

WSH

6411

0712 – Insurance (Miscellaneous)

6,009.5

20%

China Life Insurance Company L

LFC

6311

0709 – Insurance (Life)

94,339.3

20%

ProAssurance Corporation

PRA

6331

0715 – Insurance (Property & Casualty)

2,698.5

19%

RenaissanceRe Holdings Ltd.

RNR

6331

0715 – Insurance (Property & Casualty)

3,949.8

18%

National Interstate Corporatio

NATL

6331

0715 – Insurance (Property & Casualty)

576.7

18%

Argo Group International Holdi

AGII

6331

0715 – Insurance (Property & Casualty)

910.3

17%

Brown & Brown, Inc.

BRO

6411

0712 – Insurance (Miscellaneous)

3,851.4

17%

AFLAC Incorporated

AFL

6321

0706 – Insurance (Accident & Health)

24,134.6

16%

Endurance Specialty Holdings L

ENH

6331

0715 – Insurance (Property & Casualty)

1,796.8

16%

W.R. Berkley Corporation

WRB

6331

0715 – Insurance (Property & Casualty)

5,455.7

15%

American Financial Group

AFG

6331

0715 – Insurance (Property & Casualty)

3,772.7

15%

Horace Mann Educators Corporat

HMN

6331

0715 – Insurance (Property & Casualty)

830.9

15%

Eastern Insurance Holdings Inc

EIHI

6311

0709 – Insurance (Life)

135.5

15%

Validus Holdings, Ltd.

VR

6331

0709 – Insurance (Life)

3,296.1

15%

CIGNA Corporation

CI

6324

0706 – Insurance (Accident & Health)

16,104.2

14%

Reinsurance Group of America I

RGA

6321

0706 – Insurance (Accident & Health)

4,143.2

14%

Safety Insurance Group, Inc.

SAFT

6331

0715 – Insurance (Property & Casualty)

715.6

14%

Chubb Corporation, The

CB

6331

0715 – Insurance (Property & Casualty)

20,701.5

13%

Loews Corporation

L

6331

0715 – Insurance (Property & Casualty)

16,854.0

13%

ACE Limited

ACE

6351

0715 – Insurance (Property & Casualty)

28,285.6

13%

HCC Insurance Holdings, Inc.

HCC

6331

0715 – Insurance (Property & Casualty)

3,937.5

13%

Travelers Companies, Inc., The

TRV

6331

0715 – Insurance (Property & Casualty)

29,108.4

13%

Coventry Health Care, Inc.

CVH

6324

0706 – Insurance (Accident & Health)

6,080.9

12%

Markel Corporation

MKL

6331

0715 – Insurance (Property & Casualty)

4,456.4

12%

Torchmark Corporation

TMK

6311

0709 – Insurance (Life)

5,103.5

12%

UnitedHealth Group Inc.

UNH

6324

0706 – Insurance (Accident & Health)

55,732.6

12%

Partnerre Ltd

PRE

6331

0715 – Insurance (Property & Casualty)

5,116.2

12%

Meadowbrook Insurance Group, I

MIG

6331

0715 – Insurance (Property & Casualty)

311.6

12%

StanCorp Financial Group, Inc.

SFG

6321

0706 – Insurance (Accident & Health)

1,704.1

12%

Prudential Financial Inc

PRU

6311

0709 – Insurance (Life)

26,777.4

12%

Infinity Property and Casualty

IPCC

6331

0715 – Insurance (Property & Casualty)

688.6

12%

Assurant, Inc.

AIZ

6311

0709 – Insurance (Life)

2,935.0

12%

Greenlight Capital Re, Ltd.

GLRE

6331

0715 – Insurance (Property & Casualty)

837.4

12%

Progressive Corporation, The

PGR

6331

0715 – Insurance (Property & Casualty)

13,738.8

11%

Protective Life Corp.

PL

6311

0709 – Insurance (Life)

2,451.0

11%

Axis Capital Holdings Limited

AXS

6331

0715 – Insurance (Property & Casualty)

4,508.1

11%

Molina Healthcare, Inc.

MOH

6324

0706 – Insurance (Accident & Health)

1,300.1

11%

American Equity Investment Lif

AEL

6311

0709 – Insurance (Life)

834.1

11%

Symetra Financial Corporation

SYA

6311

0709 – Insurance (Life)

1,578.3

11%

Aon PLC

AON

6411

0712 – Insurance (Miscellaneous)

18,199.1

10%

Mercury General Corporation

MCY

6331

0715 – Insurance (Property & Casualty)

2,169.0

10%

Everest Re Group Ltd

RE

6331

0715 – Insurance (Property & Casualty)

5,843.7

10%

American Safety Insurance Hold

ASI

6331

0715 – Insurance (Property & Casualty)

197.1

10%

Prudential Public Limited Comp

PUK

6311

0709 – Insurance (Life)

38,071.4

10%

Aspen Insurance Holdings Limit

AHL

6331

0715 – Insurance (Property & Casualty)

2,324.9

10%

Berkshire Hathaway Inc.

BRK.A

6331

0715 – Insurance (Property & Casualty)

236,577.4

9%

EMC Insurance Group Inc.

EMCI

6331

0715 – Insurance (Property & Casualty)

326.3

9%

RLI Corp.

RLI

6331

0715 – Insurance (Property & Casualty)

1,439.1

9%

Hanover Insurance Group, Inc.,

THG

6331

0715 – Insurance (Property & Casualty)

1,781.6

9%

Unico American Corporation

UNAM

6331

0715 – Insurance (Property & Casualty)

66.6

9%

Montpelier Re Holdings Ltd.

MRH

6331

0715 – Insurance (Property & Casualty)

1,318.1

9%

Seabright Holdings Inc

SBX

6331

0715 – Insurance (Property & Casualty)

249.0

9%

Alleghany Corporation

Y

6331

0715 – Insurance (Property & Casualty)

5,950.7

8%

Hallmark Financial Services, I

HALL

6331

0715 – Insurance (Property & Casualty)

176.8

8%

White Mountains Insurance Grou

WTM

6331

0715 – Insurance (Property & Casualty)

3,509.0

8%

Investors Title Company

ITIC

6361

0715 – Insurance (Property & Casualty)

139.1

8%

Marsh & McLennan Companies, In

MMC

6411

0712 – Insurance (Miscellaneous)

19,020.9

8%

FBL Financial Group

FFG

6311

0709 – Insurance (Life)

869.4

8%

Erie Indemnity Company

ERIE

6331

0715 – Insurance (Property & Casualty)

3,264.4

8%

Metlife Inc

MET

6311

0709 – Insurance (Life)

39,615.8

8%

Aetna Inc.

AET

6324

0706 – Insurance (Accident & Health)

15,698.1

8%

WellPoint, Inc.

WLP

6324

0706 – Insurance (Accident & Health)

19,054.4

8%

Hilltop Holdings Inc.

HTH

6331

0715 – Insurance (Property & Casualty)

773.3

8%

Citizens, Inc.

CIA

6311

0709 – Insurance (Life)

485.8

7%

Donegal Group Inc.

DGICA

6331

0715 – Insurance (Property & Casualty)

370.9

7%

National Western Life Insuranc

NWLI

6311

0709 – Insurance (Life)

596.1

7%

Navigators Group, Inc, The

NAVG

6331

0715 – Insurance (Property & Casualty)

766.0

7%

Kemper Corp

KMPR

6331

0715 – Insurance (Property & Casualty)

1,842.8

7%

Allstate Corporation, The

ALL

6331

0715 – Insurance (Property & Casualty)

20,817.6

7%

Cna Financial Corp

CNA

6331

0715 – Insurance (Property & Casualty)

7,982.2

6%

Lincoln National Corporation

LNC

6311

0709 – Insurance (Life)

7,626.2

6%

Arch Capital Group Ltd.

ACGL

6331

0715 – Insurance (Property & Casualty)

6,084.7

6%

Platinum Underwriters Holdings

PTP

6331

0715 – Insurance (Property & Casualty)

1,565.0

6%

Baldwin & Lyons, Inc.

BWINB

6331

0715 – Insurance (Property & Casualty)

339.5

5%

Selective Insurance Group

SIGI

6331

0715 – Insurance (Property & Casualty)

1,086.8

5%

United Fire Group, Inc.

UFCS

6331

0715 – Insurance (Property & Casualty)

587.9

5%

Universal American Corporation

UAM

6324

0706 – Insurance (Accident & Health)

793.6

5%

Principal Financial Group Inc

PFG

6321

0706 – Insurance (Accident & Health)

8,663.8

5%

American National Insurance Co

ANAT

6331

0715 – Insurance (Property & Casualty)

2,055.2

4%

Kansas City Life Insurance Co

KCLI

6311

0709 – Insurance (Life)

416.9

4%

Cincinnati Financial Corporati

CINF

6331

0715 – Insurance (Property & Casualty)

6,771.0

3%

Independence Holding Company

IHC

6311

0709 – Insurance (Life)

169.1

3%

State Auto Financial

STFC

6331

0715 – Insurance (Property & Casualty)

582.5

3%

Unum Group

UNM

6311

0709 – Insurance (Life)

6,190.3

3%

Sun Life Financial Inc. (USA)

SLF

6311

0709 – Insurance (Life)

17,283.4

3%

Alterra Capital Holdings Ltd

ALTE

6331

0715 – Insurance (Property & Casualty)

2,861.2

3%

Assured Guaranty Ltd.

AGO

6351

0715 – Insurance (Property & Casualty)

2,911.2

3%

Fidelity National Financial In

FNF

6361

0715 – Insurance (Property & Casualty)

5,838.5

3%

Atlantic American Corporation

AAME

6311

0709 – Insurance (Life)

69.2

2%

Health Net, Inc.

HNT

6324

0706 – Insurance (Accident & Health)

2,140.7

2%

Hartford Financial Services Gr

HIG

6331

0715 – Insurance (Property & Casualty)

10,641.6

2%

ING Groep N.V. (ADR)

ING

6311

0709 – Insurance (Life)

37,878.4

2%

Manulife Financial Corporation

MFC

6311

0709 – Insurance (Life)

26,357.8

2%

Genworth Financial Inc

GNW

6311

0709 – Insurance (Life)

4,500.3

2%

AEGON N.V. (ADR)

AEG

6311

0709 – Insurance (Life)

13,073.0

1%

Old Republic International Cor

ORI

6351

0715 – Insurance (Property & Casualty)

2,994.2

1%

OneBeacon Insurance Group, Ltd

OB

6331

0715 – Insurance (Property & Casualty)

1,328.8

0%

Global Indemnity plc

GBLI

6331

0715 – Insurance (Property & Casualty)

555.8

-4%

CNO Financial Group Inc

CNO

6311

0709 – Insurance (Life)

2,192.9

-5%

Crawford & Company

CRD.B

6411

0712 – Insurance (Miscellaneous)

326.7

-5%

Stewart Information Services C

STC

6361

0715 – Insurance (Property & Casualty)

536.7

-9%

XL Group plc

XL

6331

0715 – Insurance (Property & Casualty)

8,182.5

-9%

Phoenix Companies, Inc., The

PNX

6311

0709 – Insurance (Life)

155.4

-14%

First Acceptance Corporation

FAC

6331

0715 – Insurance (Property & Casualty)

51.2

-17%

Radian Group Inc.

RDN

6351

0715 – Insurance (Property & Casualty)

820.6

-23%

MBIA Inc.

MBI

6351

0715 – Insurance (Property & Casualty)

1,561.5

-24%

Kingsway Financial Services In

KFS

6331

0715 – Insurance (Property & Casualty)

53.4

-25%

MGIC Investment Corp.

MTG

6351

0715 – Insurance (Property & Casualty)

567.7

-28%

American International Group,

AIG

6331

0715 – Insurance (Property & Casualty)

51,803.5

-32%

eHealth, Inc.

EHTH

6411

0712 – Insurance (Miscellaneous)

501.2

Maiden Holdings, Ltd.

MHLD

6331

0715 – Insurance (Property & Casualty)

725.7

United Insurance Holdings Corp

UIHC

6331

0715 – Insurance (Property & Casualty)

92.7

Homeowners Choice, Inc.

HCI

6331

0715 – Insurance (Property & Casualty)

240.0

Verisk Analytics, Inc.

VRSK

6411

0712 – Insurance (Miscellaneous)

9,103.9

Primerica, Inc.

PRI

6311

0709 – Insurance (Life)

1,868.1

First American Financial Corp

FAF

6361

0715 – Insurance (Property & Casualty)

2,648.6

Imperial Holdings, Inc.

IFT

6411

0712 – Insurance (Miscellaneous)

86.3

Fortegra Financial Corp

FRF

6411

0712 – Insurance (Miscellaneous)

177.3

Now, it makes a lot of difference how dividends are set, and how buybacks are done. Dividends should reflect a conservative estimate of how much free cash flow that a company is willing to part with. Buybacks should only be done when it is at a discount to the intrinsic value of the firm. If you have to distribute capital when the stock price is above fair market value, do a special dividend.

And when capital is dear, stop the buyback, maybe even reduce the dividend, or do a small secondary IPO. When there are genuinely profitable opportunities to write business take them.

This is yet another reason why insurance stocks tend to trade near book — capital is so flexible that if capital can enter and exit easily, it should trade near book, because capital enters and exits at book, for the most part.

Ignore the extremes, but realize that companies that compound their fully converted book values can be excellent investments.